Starting FY28, Indian banks will adopt the expected credit loss (ECL) model for provisioning on bad loans, replacing the current incurred loss model. According to a report by The Hindu BusinessLine, the ECL model is inherently more proactive in recognising credit risk and, by virtue of the RBI’s regulations, raises the baseline provision coverage significantly. This shift will not only affect banks but also influence borrowing costs—especially for borrowers who do not closely monitor their credit scores.
The ECL Model’s Impact on Banks and Borrowers
Under the current incurred loss model, provisions are made only after a trigger event—such as default or non-repayment—occurs. The ECL model, by contrast, requires banks to recognise credit risk earlier and set aside provisions before defaults materialise. As the report notes, “defaults are just outcomes of credit risk which may be brewing for quite a while.” The new framework significantly raises the baseline provision coverage, increasing banks' cost of funds for riskier lending. Consequently, lenders will pass on higher costs to borrowers through elevated interest rates, particularly for those with lower credit scores.
Credit Score Tiers and Lending Rates
Credit scores—three-digit numbers between 300 and 900—measure an individual’s creditworthiness. Higher scores indicate lower probability of default, prompting banks to charge lower interest rates. Conversely, lower scores attract higher rates. The report outlines four distinct score buckets:
| Credit Score Range | Tier Description | Implication for Borrowers |
|---|---|---|
| 750 – 900 | Top tier | Best interest rates; 79% of loans go to this group |
| 650 – 749 | Upper-middle | Slightly higher rates |
| 500 – 649 | Lower-middle | Higher rates; less favourable terms |
| 300 – 499 | Bottom tier | Very high rates or likely rejection |
Data from CIBIL reveals that 79 per cent of all loans are sanctioned to persons with scores more than 750. Borrowers in the bottom tiers face not only higher costs but also a high probability of loan rejection.
Implications for Corporate Borrowers and Treasury Professionals
While the report focuses on individual credit scores, the regulatory shift has direct implications for corporate borrowing costs. Banks subject to higher provision requirements under the ECL model will seek to maintain risk-adjusted returns across all lending portfolios, including trade finance and working capital facilities. Treasury professionals and CFOs should expect tighter credit assessment and pricing differentiation based on the creditworthiness of the borrowing entity—or even the guarantor’s personal credit score for small and medium enterprises. The proactive risk recognition under ECL may also accelerate covenant triggers and margin calls in loan agreements. As the report emphasises, “banks and NBFCs are in the risk business” and will adjust pricing accordingly. Maintaining a strong credit profile—whether corporate or personal—will become even more critical from FY28 onward.
Sources:
